inflation


Screen Shot 2015-11-18 at 4.55.47 PM

The federal debt has gone from astounding to unbelievable to incomprehensible, a new problem has emerged: The US government is actually running out of places to borrow.

How Many Zeros Are in a Trillion?

The $20 trillion debt is already twice the annual revenues collected by all the world’s governments combined. Counting unfunded liabilities, which include promised Social Security, Medicare, and government pension payments that Washington will not have the money to pay, the federal government actually owes somewhere between $100 trillion and $200 trillion. The numbers are so ridiculously large that even the uncertainty in the figures exceeds the annual economic output of the entire planet.

Since 2000, the federal debt has grown at an average annual rate of 8.2%, doubling from $10 trillion to $20 trillion in the past eight years alone. Who loaned the government this money? Four groups: foreigners, Americans, the Federal Reserve, and government trust funds. But over the past decade, three of these groups have cut back significantly on their lending.

Foreign investors have slowed the growth in their lending from over 20% per year in the early 2000s to less than 3% per year today. Excluding the Great Recession years, American investors have been cutting back on how much they lend the federal government by an average of 2% each year.

The Fed is the only game left in town.

Social Security, though, presents an even bigger problem. The federal government borrowed all the Social Security surpluses of the past 80 years. But starting this year, and continuing either forever or until Congress overhauls the program (which may be the same thing), Social Security will only generate deficits. Not only is the government no longer able to borrow from Social Security, it will have to start paying back what it owes – assuming the government plans on making good on its obligations.

With federal borrowing growing at more than 6% per year, with foreign and American investors becoming more reluctant to lend, and with the Social Security trust fund drying up, the Fed is the only game left in town. Since 2001, the Fed has increased its lending to the federal government by over 11% each year, on average. Expect that trend to continue.

Inflation to Make You Cry

For decades, often in word but always in deed, politicians have told voters that government debt didn’t matter. We, and many economists, disagree. Yet even if the politicians were right, the absence of available creditors would be an insurmountable problem—were it not for the Federal Reserve. But when the Federal Reserve acts as the lender of last resort, unpleasant realities follow. Because, as everyone should be keenly aware, the Fed simply prints the money it loans.

A century of arguing about how much to increase spending has left us with a debt that dwarfs the annual economic output of the planet.

A Fed loan devalues every dollar already in circulation, from those in people’s savings accounts to those in their pockets. The result is inflation, which is, in essence, a tax on frugal savers to fund a spendthrift government.

Since the end of World War II, inflation in the US has averaged less than 4% per year. When the Fed starts printing money in earnest because the government can’t obtain loans elsewhere, inflation will rise dramatically. How far is difficult to say, but we have some recent examples of countries that tried to finance runaway government spending by printing money.

From 1975 to 1990, the Greek people suffered 15% annual inflation as their government printed money to finance stimulus spending. Following the breakup of the Soviet Union in the 1990s, Russia printed money to keep its government running. The result was five years over which inflation averaged 750%. Today, Venezuela’s government prints money to pay its bills, causing 200% inflation which the International Monetary Fund expects to skyrocket to 1,600% this year.

For nearly a century, politicians have treated deficit spending as a magic wand. In a recession? We need jobs, so government must spend more money! In an expansion? There’s more tax revenue, so government can spend more money! Always and everywhere, politicians argued only about how much to increase spending, never whether to increase spending. A century of this has left us with a debt so large that it dwarfs the annual economic output of the planet. And now we are coming to the point at which there will be no one left from whom to borrow. When creditors finally disappear completely, all that will remain is a reckoning.

Screen Shot 2015-11-18 at 4.55.47 PM

Inflation isn’t dead; it just might not be where you think it is.

To find significant price increases, you need only look in the right places. There are many goods and services with rising prices, as well as those without. Together, they tell a fascinating tale about the modern global economy. Understanding the forces driving prices higher — or not — is crucial to investors and policy makers alike.

Given that the Federal Reserve has been trying to generate inflation for much of the past decade, the significance of the distribution is both important and telling. Why some prices are rising at twice the median rate of general inflation is worth delving into.

Look at the chart below: it show specific categories of goods and services versus the entire basket of goods and services that makes up the consumer price index.

*see below

Source: American Enterprise Institute

Let’s look a little more deeply at each category.

Textbooks:  The industry operates as a quasi-monopoly. A student assigned a given text book doesn’t have much choice. The rise of used-book exchanges provided some competition, but the publishers merely issue revised editions that are neither new nor improved. Inflation here is a function of rentier capitalism. Note that other kinds of books have fallen in price during the same period.

College Tuition: Blame demographics, guaranteed student loans and administrative bloat. The baby boomers’ kids created many more potential college students than there were seats, leading to an imbalance in demand and supply. Responses varied from adding more professors to expanding class sizes to opening new schools.

But most schools responded by raising tuition.

And students paid. The Federal Reserve Bank of New York and theNational Bureau of Economic Research looked at increases in student borrowing, funded largely through federal student-loan programs. There is a good argument to be made that this is what has drivenmuch of the increase in college tuition.

Medical Care: The bottom line in the relentless rise in health-care costs is that market forces don’t work very well in this industry. This is why every modern industrialized country, except the U.S., has a single-payer government option or something like it. Even worse, the drug industry has persuaded Congress to bar government-run health programs from negotiating lower prices.

Food and Beverages: Prices for milk, beef and most other foodstuffs soared in the 2000s, as the U.S. dollar lost 41 percent of its value (many commodities are priced in dollars) and commodity prices soared.

Housing: During the 2000s housing boom, when lending standards evaporated, home prices went up two and three times their normal rates. But the Bureau of Labor Statistics had the cost of housing as falling. Why? The BLS uses something called owner’s equivalent rent, and it tends to give false reads on housing prices.

When more people are buying and driving up home prices, it means less demand for rental units, leading to lower prices. During the housing bust circa 2006-2011, they showed the opposite. Fewer buyers meant more renters, and so rental price gains were robust.  I don’t know the best way to gauge real estate prices, but tracking owners’ equivalent rent creates a distortion.

Toys: Manufacturing has been outsourced to lowest cost parts of world, hence prices have plummeted.

Wireless Services, Software, TVs: Technology prices benefit from two key factors: the technology adoption lifecycle and manufacturing economies of scale. The long and short of it is that as new products enter the mass market  they move down the unit-cost scale, from quirky one-off devices to cheap commodity goods. Think about the first flat screen televisions at more than $10,000 plus; versions that are as good or better than those now cost $500.

So what might we conclude from looking at the chart’s component parts? Maybe only that it’s a little easier to see why the Fed has been having a hard time getting inflation to rise. While some prices are indeed up, many powerful forces have driven other prices lower — and these are forces that the Fed can’t easily influence. Until there is a substantial and sustained increase in wages (or a huge drop in the dollar), inflation may very well remain below the Fed’s 2 percent target for a long time to come.

Screen Shot 2016-08-25 at 10.34.18 AM

Screen Shot 2015-11-18 at 4.55.47 PM

James Grant, Wall Street expert and editor of the investment newsletter «Grant’s Interest Rate Observer», warns of a crash in sovereign debt, is puzzled over the actions of the Swiss National Bank and bets on gold.

From multi-billion bond buying programs to negative interest rates and probably soon helicopter money: Around the globe, central bankers are experimenting with ever more extreme measures to stimulate the sluggish economy. This will end in tears, believes James Grant. The sharp thinking editor of the iconic Wall Street newsletter «Grant’s Interest Rate Observer» is one of the most ardent critics when it comes to super easy monetary policy. Highly proficient in financial history, Mr. Grant warns of today’s reckless hunt for yield and spots one of the biggest risks in government debt. He’s also scratching his head over the massive investments which the Swiss National Bank undertakes in the US stock market.

About James GrantJames Grant, financial journalist and historian, is the founder and editor of «Grant’s Interest Rate Observer», a twice-monthly journal of the investment markets and must read for financial professionals. A former Navy gunner’s mate, he earned a master’s degree in international relations from Columbia University and began his career in journalism in 1972, at the Baltimore Sun.

He joined the staff of Barron’s in 1975 where he originated the «Current Yield» column. Mr. Grant is the author of several books covering both financial history and biography. His latest book, «The Forgotten Depression: 1921 – The Crash That Cured Itself», was published at the end of 2014. Mr. Grant is a 2013 inductee into the Fixed Income Analysts Society Hall of Fame. He is a member of the Council on Foreign Relations and a trustee of the New-York Historical Society. He and his wife live in Brooklyn. They have four grown children.Jim, for more than three decades Grant’s has been observing interest rates. Is there anything left to be observed with rates this low?


Interest rates may be almost invisible but there is still plenty to observe. I observe that they are shrinking and that the shrinkage is causing a lot of turmoil because people in need of income are in full hot pursuit of what little of yields remains.

What are the consequences of that?
It reminds me of the great Victorian English journalist Walter Bagehot. He once said that John Law can stand anything but he can’t stand 2%, meaning that very low interest rates induced speculation and reckless investing and misallocation of capital. So I think Bagehot’s epigraph is very timely today.

John Law was mainly responsible for the great Mississippi bubble which caused a chaotic economic collapse in France in the early 18th century. How is the story going to end this time?
It will turn out to be very bad for many people. If Swiss insurance and reinsurance executives are reading this right now they might be rolling their eyes and they might be frustrated to hear an American scolding from a distance of 3000 miles about the risk of chasing yield. After all, if you’re in the business of matching long term liabilities with long term assets you have little choice but to wish for a better, more sensible world. But you have to take the world as it is and today’s world is barren of interest income. The fact is, that these are very risk fraught times.

Where do you see the biggest risks?
Sovereign debt is my nomination for the number one overvalued market around the world. You are earning nothing or less than nothing for the privilege of lending your money to a government that has pledged to depreciate the currency that you’re investing in. The central banks of the world are striving to achieve a rate of inflation of 2% or more and you are lending certainly at much less than 2% and in many  cases at less than nominal 0%. The experience of losing money is common in investing. But where is the certitude of loss even before your check clears? That’s the situation with sovereign debt right now.

On a worldwide basis, more than a third of sovereign debt is already yielding less than zero percent.
There is not quite a bestseller, but a very substantial book called «The History of Interest Rates». It was written by Sidney Homer and Richard Sylla. Sidney Homer is no longer with us, but Richard Sylla is alive and well at New York University. So I called him and said: « Richard, I’ve read many pages but not every single page in your book which traces the history of interest rates from 3000 BC to the present. Have you ever come across negative bond yields?» He said no and I thought that would be kind of a major news scoop: For the first time in at least 5000 years we have driven interest rates below the zero marker. I thought that was an exceptional piece of intelligence. But I notice however that nobody seems to have picked up on it.

It’s now already two years ago since the ECB was the first major central bank to introduce negative rates.
There are some other historical settings: In Europe, Monte dei Paschi di Siena, this 500 and plus year old bank in Italy, is struggling and as broke as you can be without being legally broke. Monte dei Paschi has survived for half a millennium and now it is on the ropes. Meanwhile, the Bank of England is doing things today that it has never done in its history which is 300 plus years. So I suggest that these are at least interesting times and in many respects unprecedented ones.

So what’s the true meaning of all this?
In finance, mostly nothing is ever new. Human behavior doesn’t change and money is a very old institution and so are our markets. Of course, techniques evolve, but mostly nothing is really new. However, with respect to interest rates and monetary policy we are truly breaking new ground.

Now central bankers are even talking openly about helicopter money. Will they really go for it?
I already hear the telltale of beating rotor blades in the sky. I also hear the tom-toms of fiscal policy being pounded. There seems to be some kind of a growing consensus that monetary policy has done what it can do and that what me must do now – so say the «wise ones» – is to tax and spend and spend and spend. That seems to be the new big idea in policy. In any case, it is not good for bondholders.

Interestingly, nobody seems to be talking about the growing government debt anymore. Also, budget politics are just a side note in the ongoing presidential elections.
The trouble with this election is that somebody has to win it. I have no use for Donald Trump but I have equally no use for Hillary Clinton. The point is that one of those two is going to win. That is the tragedy! So we at Grant’s regret that one of them is going to win.

The financial crisis and the weak economic recovery likely have spurred the rise of Donald Trump. Why isn’t the US economy in better shape after all those monetary programs?
I wonder how it would have been if markets had been allowed to clear and if prices had been allowed to find their own level in real estate in 2008. Central banks have intervened to quell financial panics for at least 200 years. For instance, in 1825 the bank of England lent without stint and was not – as they said – overnice about the kind of collateral. That was a very dramatic intervention. So it’s not as if we have never before seen the lender of last resort at work. But what is new is the medication of markets through this opiate of quantitative easing year after year after year following the financial crisis. I think that this kind of intervention has not only not worked but it has been very harmful. Around the world, the economies are not responding despite radical monetary measures. To some degree, I believe,  they are not recovering because of radical monetary measures.

What’s exactly the problem with the US economy?
There is another side of what we are seeing now: In America certainly the Federal Reserve and bank regulators generally are very heavy handed in their interventions. I’m sure they have every good intention. But with their regulatory charges they are suppressing the recovery in credit that takes place  in a normal economic recovery and in this particular case after a depression or after a liquidation.

Then again, a revisit of the financial crisis would be catastrophic.
The new rules with respect to financial reform have absorbed not only forests worth of paper but also the time and attention of legions of lawyers. If you talk to a banking executive what you hear is that the banks have been overwhelmed by the need to hire compliance and regulatory people. This is especially bearing on the smaller banks. I think that’s part of the story of the lackluster recovery: Monetary policy has been radically open in the creation of new credit. But it has been radically restrictive with regard to risk taking in the private world.

So what should be done to get the economy back on track?
There are guides in history on how to do this. For more than a hundred years in Britain, in the United States and probably as well in Switzerland, the owners of the equity of a bank themselves were responsible for the solvency of the bank. If the bank became impaired or insolvent they had to stump up more capital to pay off the liability holders, including the depositors. But over the past hundred years collective responsibility in banking has gradually replaced individual responsibility. The government, with the introduction of deposit insurance, new regulations and interventions has superseded the old doctrine of the responsibility of the owners of a property. That’s why I think we need to go away from government intervention and go more towards market oriented solutions such as the old doctrine of responsibility of the bank owners.

At least in the US, the Fed is trying to go back to a more normal monetary policy. Do you think Fed chief Janet Yellen will make the case for another rate hike at the Jackson Hole meeting next week?
Janet Yellen is by no means an impulsive person. According to the « Wall Street Journal», she arrives for a flight at the airport hours early – and that’s plural! So this is a most deliberative and risk averse person. Also, as a labor economist, she’s a most empathetic person. She believes what most interventionist minded economists believe: They have very little faith in the institution of markets and they don’t believe that the price mechanism is anything special. They want to normalize rates and yet they can always find an excuse for not doing so. We have been hearing for years now that the next time, the next quarter, the next fiscal year they will act. So I believe what I’m seeing: None of these days the Federal Funds Rate will go higher than 0.5%. I can’t see that happening.

Wall Street seems to think along the same lines. So far, many investors don’t take the renewed chatter of a rate hike too seriously.
The Fed is now hostage to Wall Street. If the stock market pulls back a few percent the Fed becomes frightened. In a way I suppose, the Fed is justified in that belief because it is responsible to a great degree for the elevation of financial asset values. Real estate cap rates are very low, price-earnings-ratios of stocks  are very high and interest rates are extremely low. One can’t be certain about cause and effect. But it seems to me that the central banks of the world are responsible for a great deal of this levitation in values. So perhaps they feel some responsibility for letting the world down easy in a bear market. It has come to a point where the Fed is virtually a hostage of the financial markets. When they sputter, let alone fall, the Fed frets and steps in.

Obviously, the financial markets like this cautious mindset of the Fed. Earlier this week, US stocks climbed to another record high.
Isn’t that a funny thing? The stock market is at record highs and the bond market is acting as if this were the Great Depression. Meanwhile, the Swiss National Bank is buying a great deal of American equity.

Indeed, according to the latest SEC filings the SNB’s portfolio of US stocks has grown to more than $60 billion.
Yes, they own a lot of everything. Let us consider how they get the money for that: They create Swiss francs from the thin alpine air where the Swiss money grows. Then they buy Euros and translate them into Dollars. So far nobody’s raised a sweat. All this is done with a tab of a computer key. And then the SNB calls its friendly broker – I guess UBS – and buys the ears off of the US stock exchange. All of it with money that didn’t exist. That too, is something a little bit new.

Other central banks, too, have become big buyers in the global securities markets. Basically, it all started with the QE-programs of the Federal Reserve.
It is a truism that central banks do this. They’ve done this of course for generations. But there is something especially vivid about the Swiss National Bank’s purchases of billions of Dollars of American equity. These are actual profit making, substantial corporations in the S&P 500. So the SNB is piling up big positions in them with money that really comes from nothing. That’s a little bit of an existential head scratcher, isn’t?

So what are investors supposed to do in these bizarre financial markets?
I’m very bullish on gold and I’m very bullish on gold mining shares. That’s because I think that the world will lose faith in the PhD standard in monetary management. Gold is by no means the best investment. Gold is money and money is sterile, as Aristotle would remind us. It does not pay dividends or earn income. So keep in mind that gold is not a conventional investment. That’s why I don’t want to suggest that it is the one and only thing that people should have their money in. But to me, gold is a very timely way to invest in monetary disorder.

 

Screen Shot 2015-11-18 at 4.55.47 PM

Trump previously discussed defaulting on US debt. It of course wouldn’t be the first time, Roosevelt in 1933 in confiscating gold, defaulted.

Nixon in 1971 again defaulted, through, once again gold.

Inflation is of itself a default. Inflation has been a constant issue since the default in 1933 and will continue to be a default.

Snoopy-Typing-Away-1-CVV14J0D95-1024x768

Flippe-floppe’s oscillator. Like any oscillator, the deeper pullbacks are [i] more reliable in a bull market and [ii] are more profitable, assuming you sell at some point, to re-enter.

ppt1

Wage inflation starting to rise. Notice the correlation to interest rates.

image

snoopy-christmas-peanuts-452770_1280_96050

CPIAUCSL_Max_630_378

fredgraph

Inflation continues higher, yet, no real protest. Is the inflation a problem? Of course. Where is the economic recovery? It is still largely non-existent.

Many Frenchman soon became eternal optimists claiming that inflation was prosperity, like the drunk forgetting the inevitable hangover. Although every new issuance initially boosted economic activity, the improved business conditions became shorter and shorter after each new issuance. Commercial activity soon became spasmodic: one manufacturer after another closed shop. Money was losing its store-of-value function, making business decisions extremely difficult in an environment of uncertainty. Foreigners were blamed and heavy taxes were levied against foreign goods. The great manufacturing centers of Normandy closed down and the rest of France speedily followed, throwing vast numbers of workers into bread lines. The collapse of manufacturing and commerce was quick, and occurred only a few months after the second issuance of assignats and followed the same path as Austria, Russia, America, and all other countries that had previously tried to gain prosperity on a mountain of paper.

Social norms also changed dramatically with the French turning to speculation and gambling. Vast fortunes were built speculating and gambling on borrowed money. A vast debtor class emerged located mostly in the largest cities.

Speculation is again ubiquitous, financial markets rise in the face of falling and/or stagnant earnings, small businesses struggle, and housing is entering another speculative period after a major collapse five years ago.

Snoopy-Typing-Away-1-CVV14J0D95-1024x768

Japan Economy Up Sluggish 2.6 Percent For Quarter
AP – Sun Aug 11, 7:15PM CDT

TOKYO (AP) — Japan’s economy grew at a slower-than-expected rate of 2.6 percent last quarter, suggesting demand has been slow to pick up despite strong public spending and ultra-lax monetary policies. (full story)

Japan, which has gone all-in, full-tilt, inflation, is finding that even with all that money printing that GDP growth is tepid.

The reason for this lies in the economic axiom that is Wicksell’s the “natural rate of interest”. Where goods that are not demanded, can be manufactured or produced, due to cheap capital, viz, manipulated interest rates, then common sense tells you that an increased supply will not sell. Hence the “surprise” is really no surprise at all.

Next Page »